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Tapping into your home equity when you need to borrow money is one of the biggest financial advantages of homeownership. If you’re aware of the risks and you’re looking for a more affordable way to borrow, it’s a no-brainer. A more difficult question, however, is what type of loan to use.
Home equity loans and cash-out refinance loans are two of the most common types of home equity financing, but your costs may vary a lot between them. We’ve provided an easy-to-use home equity loan vs cash-out refinance calculator that you can use to make a more informed and confident financial decision.
How a home equity loan works
A home equity loan is a separate type of debt that’s paid out as a lump sum, like a personal loan, except that it’s also tied to your home equity. Since it’s separate from your mortgage, there’s no need to change anything with your main home loan. You can keep it in place, and your new lender will place a secondary lien on your home.
A secondary lien means your lender will be second in line to be repaid if you default on your debts. Lenders generally charge slightly higher rates on home equity loans than for mortgages in order to compensate for this risk.
You’ll generally need to have at least 80% equity in the appraised value of your home before you’re eligible to borrow against your home equity, whether you use a home equity loan, home equity line of credit, or a cash-out refinance. Most lenders also charge closing costs on a home equity loan, as well.
How home equity loan repayment works
Different lenders offer a range of term length choices, typically between five and 30 years. Most home equity loans are offered at a fixed rate, too, meaning that your payment amount will stay the same from month to month.
You can think of home equity loan repayment as compartmentalizing your debt more, which can help you save money in many cases. (A cash-out refinance, as we’ll see, combines your new debt with your main mortgage.) Even though they charge slightly higher interest rates, you may be able to pay off that debt quicker than with a 30-year refinance loan. Once you’ve paid off the new debt, that’s it — you won’t need to continue paying it along with the rest of your mortgage.
How a cash-out refinance works
A cash-out refinance works by replacing your current mortgage with a brand-new one. Normally, people do this in order to get a lower rate on their home loan or to change their term lengths in order to tweak their monthly payments. You can also refinance your home loan for a larger amount than you owe, however, and pocket the difference as cash.
For example, if you owe $500,000 and you’re 10 years into a 30-year mortgage, you may be able to refinance for a $600,000 loan with a new 30-year term length. That stretches your repayment out a further 10 years, but it also gives you $100,000 to use however you like.
Cash-out refinances also come with closing costs, but because you’re talking about a much larger loan, these fees tend to be higher than for a home equity loan. Many lenders charge slightly lower rates on a cash-out refinance compared to a home equity loan because they generally take a first-lien position if you default, meaning they’re more likely to be repaid.
How cash-out refinance repayment works
Repaying a cash-out refinance loan works basically the same as your current mortgage. Lenders may offer fixed mortgage rates or a variable interest rate that changes over time. Most cash-out refis are available in 15- or 30-year term lengths, although you can find lenders offering different options if you look around enough.
Your term length is an especially important consideration if you opt for cash-out refinancing. You can choose a 30-year term length if you’re eligible, which is common — but it also means resetting the clock on your home’s debt-free date and erases any progress you’ve made in paying off your mortgage.
Furthermore, if you choose a cash-out refi because you can take longer to pay off your new debt than if you’d gotten a shorter-term home equity loan, you could end up paying more in the long run. You can use Point’s home equity loan vs cash-out refinance calculator below to help you see which is more cost effective for your situation.
Home equity loan vs. cash-out refinance costs: An example
The idea that you could end up paying more over the long run, even with a lower interest rate, seems counterintuitive to a lot of people, so let’s see how it works.
Let’s say you’re consolidating debts and take out a $50,000, 10-year home equity loan at an 8.5% interest rate. In that case, your monthly payments will be $620 and you’ll pay $24,400 in total interest by the time you repay it.
If you instead finance it with a 30-year cash-out refinance loan at a 6.5% interest rate, the portion of your mortgage payment that goes to this new debt will be much lower, just $316. Since you’re paying interest for three times as long, however, you’ll end up paying $63,800 in total interest by the end — over twice as much compared to a home equity loan. Keep in mind this example doesn’t even include closing costs, which will also be higher for the cash-out refinance loan.
Home equity loan vs cash-out refinance: Deciding between the two
It’s a good idea to talk to a financial advisor to help you make a good decision if you're not sure. In general, however, a home equity loan may make more sense in two big cases:
- You want to keep your current mortgage: If you’re happy with your current mortgage, especially if you know you’ve locked in a lower rate than you could get with a new loan today, then choose a home equity loan.
- You want to save money on financing costs: You’ll pay interest and closing costs regardless — but because home equity loans are smaller and often shorter than cash-out refis, you’ll generally pay much less in financing charges.
On the other hand, here are some factors that could point more to a cash-out refinance as being a better choice:
- Your credit score isn’t the best: Home equity loans typically require a credit score of 680 or higher, as opposed to 620 for a cash-out refinance.
- You want a lower monthly payment: Financing your debts over a longer period of time with a cash-out refinance loan lets you shrink each payment amount. Remember, that comes with a cost, though, since you’ll pay more in interest.
- You want an adjustable-rate mortgage: Loans with variable rates are generally lower than for fixed-rate loans, but those rates may increase. If you plan to sell your home in the future and that doesn’t matter, it can be a good way to save.
- You don’t want to manage separate loans: Keeping all of your home debts together in one loan simplifies repayment. Rolling your other debt from credit cards and medical bills into the mix can also help you consolidate things under one umbrella.
- You can get a lower interest rate on a new mortgage: If you would already be getting a lower rate with a standard rate-and-term refinance loan, then taking out a bit extra in cash can be just the extra nudge you need.
Home equity loan vs cash refinance calculator
If either financing option would work for you, then making a decision can be even harder. This calculator can help you shed some light on how much each option costs with just a few bits of data on your end:
- Current home value: How much your home is currently worth. You can get a reasonable estimate by comparing websites like Zillow and Redfin.
- Current mortgage principal: How much is left to pay off on your current mortgage. You can see this number listed as the remaining balance on your last mortgage statement.
- Remaining mortgage term: How much time you have left to pay off your current mortgage, as originally scheduled (not counting if you’ve been paying extra).
- Current mortgage rate: Your current annual percentage rate (APR), which should also be listed in your most recent mortgage statement.
- Credit score: Pick which range of credit scores you fall into. Many bank or credit card companies offer this information for free; check with your financial institutions.
- Loan amount: Enter how much you’re looking to borrow in cash, separate from your mortgage.
- Term length: Choose the length of time you’re looking to pay off your debt.
In return, here’s what the calculator will show you:
- Savings: How much money you may be able to save over the life of your loan by choosing the recommended product: home equity loan or cash-out refinance.
- APR: The rate you can expect to pay on your new debt based on the information you entered.
Final thoughts
You can help your family live a better life with home equity financing tools that offer many benefits over other types of debt, such as lower rates. If you're using the funds for certain purposes, like upgrading your home, the interest you pay may even be tax deductible.
You’ll need to make sure that you’re using the right tool for the job, however, and that’s where checking your numbers with this home equity loan vs cash-out refinance calculator can help. Don’t stop there, though — make sure you consider all other options as well, such as:
- Home equity investments
- Home equity lines of credit
- Saving up more money in advance
- Financial assistance, such as grants or charity aid
- Unsecured debts like personal loans and credit cards
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